Global debt ratio declines but emerging markets return to record highs, IIF says

Emerging markets' debt-to-GDP ratio returns to record high of 254% last seen in Q1 of 2021

Brooklyn, New York. The US was the only country in the IIF's study to record an increase in total debt during the third quarter of 2022. Photo: NYC & Company

The global ratio of debt to gross domestic product fell for a sixth consecutive quarter in the July-September period to 343 per cent of GDP but the International Institute of Finance said emerging markets had bucked this trend as their ratios returned to record highs.

The world's debt-to-GDP ratio is now 20 percentage points lower than its peak in the first quarter of 2021, helped by high inflation that has been particularly strong after a surge in commodity prices as a result of the Ukraine war, the IIF said in its latest Global Debt Monitor report.

The global debt pile declined by $6.4 trillion in the third quarter to $290 trillion due to a strong US dollar and high interest rates that both weighed on bond issuances, the IIF said.

This is more than $15 trillion below its record of $306 trillion in the first quarter of 2022.

The drop is underscored by the strengthening greenback, which makes loans denominated in other currencies look smaller when they are measured using the US dollar.

“With central banks still struggling to contain the inflation shock, higher price levels have temporarily improved the debt servicing capacity of many borrowers: corporate pricing power has supported earnings growth while sovereigns have benefitted from higher consumption tax revenues,” the Washington-based institute said.

Inflation has continued to push interest rates and funding costs higher globally while governments have ramped up spending to shore up economies.

The International Monetary Fund expects global inflation to peak in late 2022 at 8.8 per cent and to remain elevated for longer than previously expected, before decreasing to 4.1 per cent by 2024. The fund estimates inflation at 6.5 per cent in 2023.

“With global funding conditions tightening rapidly, borrower appetite and [the] ability to tap [into] international debt markets have declined significantly this year,” the institute said.

“The ensuing sharp slowdown in debt issuance — coupled with the strength of the greenback — has reduced the US dollar value of outstanding global debt.”

The drop in debt levels during the third quarter was sharper in mature markets, driven by Japan, the UK, France and Canada.

The US was the only country in the IIF's study to record an increase in total debt during the three-month period.

Across emerging markets, China, Korea and Russia had the largest declines, the IIF said.

Emerging markets

The debt-reduction impact of inflation has not been enough to curb debt ratios in many emerging markets, the IIF report showed.

Persistently large budget deficits — coupled with subdued economic growth — have brought the emerging markets' debt-to-GDP ratio back to its record high of 254 per cent, last registered in the first quarter of 2021, the institute said.

Emerging market government debt topped 65 per cent of GDP in the third quarter, and emerging market financial sector debt surpassed 40 per cent of GDP as banks accelerated borrowing, it said.

For many high-yield borrowers this year, the median yield spread is about 400 basis points higher than a year ago but the upswing in spreads has been more limited for investment-grade borrowers, the IIF said.

“In the face of tightening global financing conditions, access to international markets has become even more challenging for many high-yield borrowers this year,” the IIF said.

“The global sovereign interest bill is set to increase rapidly, notably for sub-Saharan Africa but also in EM Europe.”

The interest rates increases imposed by central banks in response to high inflation rates will have a disproportionate impact on lower-income households and small companies, given their high reliance on funding with a short maturity, the IIF said.

High interest rates will also increase debt-servicing costs for heavily indebted businesses and governments.

“Higher funding costs represent a major source of risk for financial and social stability across countries with highly indebted sectors,” the IIF said.

“With fiscal deficits remaining higher than pre-pandemic levels in many countries, government debt servicing costs are expected to surge in [the] G7, EM [emerging markets in] Europe and sub-Saharan Africa,” the report said.

Higher borrowing costs could particularly undermine already fragile debt situations in sub-Saharan African countries, leaving many nations struggling to source urgently needed climate finance, it said.

“The implications could be even more severe for those that lack credible investor relation programmes and debt disclosure practices,” the IIF warned.